There are various Chinese companies working in Pakistan. A lot of these companies are working on infrastructure projects involving constructions of Power Projects, Dams and Highways. These companies then further contract out parts of the work involving designing and engineering of the works to other companies who are resident in China. A legal proposition arises when these companies are tasked with deducting tax from payments to Chinese resident companies under the Income Tax Ordinance 2001. The Chinese resident companies rightfully object since they are already being taxed under China's own tax regime and additionally being taxed under the Pakistan tax regime appears unfair to them.
China and Pakistan both are signatories to the Agreement between Peoples Republic of China and the Islamic Republic of Pakistan for avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Evasion of Taxes. This tax treaty was signed in 1989 and specifically deals with the issues of double taxation. We are however surprised to find that most Chinese companies are either not aware of this treaty or have not given it the due consideration they ought to have. Even if the Chinese Companies refer to the Treaty for relief, the problem of interpretation of the articles which they are faced with leads them astray.
For the purposes of this paper we have tried to demonstrate this problem of interpretation and also the mechanism which may be employed to resolve it.
The Treaty
Article 1 of the Treaty provides that it shall apply to persons who are residents of one or both of the Contracting States. Article 2 (2) provides that it shall apply to income tax in Pakistan and China. Article 3 defines Contracting States as meaning China or Pakistan as context so requires. Article 4 for the purposes of the Treaty defines the term Resident as a person who under the laws of that Contracting State is liable to tax therein by reason of his domicile, residence, place of head of office or effective management or any other criteria of a similar nature.
The interpretation of Article 13 (2)
Article 7 provides that the profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State.
Article 15 provides that income being derived from a resident of a Contracting State shall only be chargeable in that Contracting State unless it the beneficial owner of the fees also has a place of establishment or base in the other Contracting State.
Article 13 (1) provides that Fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. Article 13 (2) provides that such fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the recipient is the beneficial owner thereof, the tax so charged shall not exceed 12.5% of the gross amount of the fees. Article 13 (4) provides that the provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the fees for technical services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein and the contract in respect of which the fees for technical services are paid is effectively connected with such permanent establishment or fixed base. In such cases the provisions of Article 7 or Article 15, as the case may be, shall apply.
Where as Articles 7 , 13 (1) and 15 in our opinion are clear that taxation on the fees being paid to a resident shall only take place in the country of which the beneficial owner of the fees is a resident, the problem arises from the interpretation of Article 13 (4).
Article 13 (4) provides that the provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the fees for technical services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein and the contract in respect of which the fees for technical services are paid is effectively connected with such permanent establishment or fixed base.
A plain reading of Article 13 (4) would make it clear that it nullifies the effect of Article 13 (1) if the resident of China also has a business establishment in Pakistan. But Article 13 (4) also provides that it shall nullify the effect of Article 13 (2) which provides that such fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the recipient is the beneficial owner thereof, the tax so charged shall not exceed 12.5% of the gross amount of the fees.
The Litmus Test for Article 13 (2)
The legal proposition which arises then is that under the Treaty will the services be taxed in China or Pakistan? Our interpretation is that the name of the Treaty provides that it has been signed specifically to avoid the issue of double taxation. Where as Article 7, 13 (1) and 15 are clear that such fees shall only be taxed in China, the question of interpretation of Article 13 (4) read with Article 13 (2) can be resolved by the litmus test of whether the Chinese resident company also has a place of establishment in Pakistan or not. If it does it will be taxed in Pakistan too under Article 13 (2) and if it doesn't it will be taxed only in China under articles 7, 13 (1) and 15 of the Treaty.
The Relief provided by the Treaty
When confronted with a problem regarding the interpretation of the Articles of the Treaty, it is important in our opinion to see the purpose for which the Treaty has been signed which is the avoidance of double taxation. Since the Treaty's main purpose is the avoidance of double taxation, in our opinion this prime purpose is which the Treaty will try to first achieve followed secondly by exceptions where the Treaty in fairness will accord benefit to the revenue collection of Pakistan where the Chinese company is also operating a place of business in Pakistan.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
